ALEXANDRIA, VA (July 14, 1999) -- After last week's Back to Basics series (Parts 1, 2, 3, 4), I received a ton of e-mails requesting help in digging up the necessary financials for calculating margins, growth rates, Flowie, et al. My initial response was, "No problem, just go to the K or Q." But then I remembered how I felt the first time I, myself, looked at a company's annual 10-K or quarterly 10-Q.

It was... well... painful. Heck, it was tough just finding the 10-K or 10-Q among the Security and Exchange Commission's (SEC) alphabet soup of filings. And then after finding the derned thing, I was assaulted by 50 pages of items, lists, tables, and non-stop legalese. Are the balance sheet and income statement really hidden somewhere in this mess? My eyelids grew heavy, my mind began to wander, I gave up.

No doubt about it, getting down and dirty with the Ks and Qs is an adventure the first few times around. But then, on about the third or fourth try, something strange happens. You begin to see consistencies with how the reports are structured, and next thing you know, it's actually... ... pretty easy! Just to prove it, I want to spend today's report walking through every step involved in looking up the essential numbers for our five financial metrics of the Rule Maker Criteria. So, grab your calculator, and let's turn our attention to pharmaceutical maker Schering-Plough's(NYSE: SGP) 1998 10-K.

Step 1: Where are SEC Filings located?

Free SEC filings are available at a number of websites, including the popular FreeEDGAR.com, but there's no need to stray because we have the goods right here on the Fool site. Go ahead and open another browser window and click the "Quotes/Data" tab at the top of this page, or if you're into URLs, go to quote.fool.com. Once you're there, you'll have access to stock quotes, earnings estimates, a snapshot of the company's business, and of course SEC filings. On the left side of the page, under the "Data" heading, type in Schering's ticker "SGP" and click "SEC Filings."

Step 2: So many Forms! Which one?

Okay, now you're facing a long list of reports, forms, proxies, and other bewildering names, each of which corresponds to an even more bewildering series of letters and numbers. Not to worry, all we need is the most recent 10-K (or sometimes the 10-K405), which is labeled as "annual report." Since the filings are listed by date, starting with the most recent one, simply skim down the far-right column until you see "10-K." In this case, you'll see a form called the "10-K405," which was filed on 2/25/99 -- that's the one you want. Go ahead and click into it. (If you were looking for the most recent quarterly filing, you'd click on the 10-Q filed on 5/13/99.)

Step 3: Items, Tables, Parts... where are the financials?!

The target is in sight now. Within that massive Table of Contents, you'll see lots of tables, lists, and items -- ignore all that stuff for now. Scroll all the way down until you see the following:

Alright, we've found the financial statements. That wasn't so bad, was it? Most 10-Ks and 10-Qs are structured in this fashion, with the three major financial statements clustered together. Now, we're ready to pluck the few pieces of financial data that will allow us to calculate our five essential financial metrics: 1) sales growth, 2) gross margins, 3) net margins, 4) cash-to-debt ratio, and 5) Flow Ratio. Today, we're just going to focus on finding the numbers and performing the calculations. If you have questions about the rationale behind these metrics, refer to the links below.

Looking at the top line of the income statement, we see "net sales" for 1998, 1997, and 1996. Sales have been increasing steadily, but by how much? Simply take 1998 net sales of $8,077 million and divide it by 1997 net sales of $6,778 million. The result is 1.192, or 19.2% growth, which is a very good increase in sales, especially for a relatively mature company like Schering-Plough.

Continuing with the income statement, calculating Schering's 1998 gross margin is a two-step process. First, we calculate the gross profit, which is net sales of $8,077 million minus cost of sales of $1,601 million, which gives us a gross profit of $6,476 million. Second, to calculate the margin, we take the gross profit divided by net sales, which equals 80.2%. That means that even after deducting the cost of the physical materials and labor that go into making capsules of Claritin, Dr. Scholl's corn removers, and Schering's other healthcare products, the company is left with an 80.2% gross profit margin. Looked at in the inverse, Schering marks up its product by over 5 times the input costs.

We're still on the income statement with this one. The net margin calculation is just the bottom-line 1998 net income of $1,756 million divided by the top-line sales of $8,077 million. The result is 21.7%, which means that for every dollar of sales, Schering books a profit of more than two dimes -- very good. Typically, we look for companies that can deliver at least 7% net margins, but Schering-Plough, like most pharmaceutical companies, is much more profitable.

That's it for the income statement. For the next two metrics, let's click over to the balance sheet, looking at both the assets and liabilities.

This one can sometimes be a little tricky because "cash" includes not only straight cash, but also cash equivalents such as marketable securities and short-term investments. In Schering's case, however, all of the cash & equivalents are consolidated in one line. Looking at the assets side of the balance sheet, we see a cash balance of $1,259 million. Now, moving over to the liabilities side of the balance sheet, we need to find ALL interest-bearing debt, both short- and long-term. In the Current Liabilities section, short-term debt is identified as "short-term borrowings and current portion of long-term debt," and has a balance of $558 million. Under Long-term Liabilities, long-term debt is labeled as -- get this -- "Long-term debt," and has a balance of $4 million. Summing the short- and long-term varieties of debt gives us $562 million in total debt. Then, taking cash divided by total debt yields a cash-to-debt ratio of 2.24x, which is a little better than our benchmark of 1.5x.

Finally, to round out our balance sheet analysis, we must calculate this useful little thing called the Flow Ratio. We need to collect four pieces of data: 1) cash, 2) total current assets, 3) short-term debt, and 4) total current liabilities. First, from the assets side of the balance sheet, we need cash & equivalents and total current assets. The cash balance for the Flowie is the same as the one we just used in the cash-to-debt ratio -- $1,259 million. Four lines below the cash balance, total current assets is listed as $3,958 million. Next, on the liabilities side, we need short-term debt and total current liabilities. As we found when calculating the cash-to-debt ratio, short-term debt is $558 million. A few lines below the short-term debt, total current liabilities is $3,032 million. Okay, with data in hand, we can now run our ratio, which is:

Ideally, we prefer a Flowie below 1.0, but 1.09 is still pretty darn good, and below our "official" standard of 1.25.

Nothing to it, right? If this exercise seemed a bit tedious, please know that it gets easier and easier each time you do it. After three or four go-rounds, you'll have it down pat. And, the rewards are great for investors that understand these basics of financial analysis. At the very least, knowledge of these metrics will help keep you out of really bad investments, such as the horrific story I presented here a few weeks ago.

If you have any questions about this stuff, click over to the Rule Maker Beginners board where a number of helpful Fools can lend you a hand.

Tomorrow, Phil is back to offer a Foolish take on Intel's earnings, and on Friday, Rob will report on Coca-Cola's earnings, which are due on Thursday evening.

Note: The Rule Maker Portfolio began with $20,000 on February 2, 1998, and it added $2,000 in August 1998 and February 1999. Beginning in July 1999, $500 in cash (which is soon invested in stocks) is added every month.